Did you know that the way that you go about investing your money can make a significant difference to the amount you can earn? You could get more or less depending on how and when you decide to get started. Although it may seem like the same amount of money would lead to a similar amount of potential profit, over time there are a number of economic laws which will come into play, often leading to different results. In this article we will go through each of these concepts, to help you make the right investment decisions for your money. As you consider the best path for your investments, don’t forget that you’re also entitled to annual tax relief if you invest with a Stocks and Shares ISA.
When is the best time to invest a lump sum of money?
Receiving a large lump sum of cash can sometimes be overwhelming, especially if it is from a life changing event such as a redundancy, inheritance or house sale. At this moment, you may be considering potential future upheavals and thinking about how you can preserve your money for later. Fortunately, there are a range of options available to help you make the most of your newly found wealth.
Investing could be a good avenue for you. It could help you to not only preserve your money in several ways, but it could also help you grow your wealth too. By putting most, or all, of your lump sum into an investment plan early on, you could be in a position to afford your dreams later on in life.
The sooner you start, the better
One of the major advantages to investing a large amount of money early on is known as “compounding”. Compounding is when the profits you make are reinvested back into the investment plan. This will mean that you have more money to invest and so you can make bigger profits as a result. By doing this over and over and provided the environment is favourable, your returns become “compounded”, meaning that you could be on the receiving end of a positive spiral of profit and investment. It is an extraordinary advantage of investing, which can sometimes feel unreal. What is very real is the return it could create for long-term investors.
Our Senior Investment Manager Andrew Amy recently referenced the fascinating case of secret millionaire Grace Groner in his article “3 ways you could make more money by investing”. Mrs Groner is a striking example of how compounding works over time - at the age of 25 she bought just three shares in her company for $180 and then did nothing. Over the subsequent 75 years those shares felt the benefit of compounding, as the profits were reinvested and the stock split. Upon her deathbed this seemingly low-income elderly lady bequeathed more than $7.2 million dollars to a scholarship programme with just those three shares.
The power of compounding is truly life-changing. Given enough time, small investments could quietly become enormously lucrative. With compounding, the phrase “patience is a virtue” couldn’t be more true, the time you start investing could be as important as how much you invest. The sooner, the better. If you are able to invest a lump sum early on, this could open up a bright financial future and allow you to truly live your dreams.
When should you start investing with regular payments ( or “drip feeding”)?
Drip feeding means that you could pick up some investment bargains
Like most investors, you probably want to buy low and sell high. This is the general philosophy for almost every investment including property, gold and collectables. It would be great to achieve this… but how is it actually possible? You would need to have nerves of steel to buy stock while it is plummeting. How can you figure out the exact perfect time to invest in cheaper stocks when you are so caught up in the moment? With all the emotions and market noise, most people will unintentionally follow the herd and back out too soon or sell too late.
There is, however, a tried-and-tested technique in the investment industry, which is known as “pound-cost averaging”. Although it might sound quite technical, it essentially means adding money on a regular basis into your investment plan. For example, if every payday you deposit £50 of your salary into your investment plan, you are taking advantage of pound-cost averaging.
Pound-cost averaging means that during market downturns you can buy more investments for your money (because stocks and shares are cheaper). If the market moves upwards again, you will have reaped more of the profits because you now have more investments. It’s a simple but striking solution and investment managers use it all the time.
Drip feeding money could smooth out the highs and lows of investing
As well as allowing you to buy investments at lower prices during market downturns, it also could help to smooth out your performance. What we mean by this is that because you can afford to buy more investments when markets go south, and less when the markets are doing well, you don’t have so many extreme highs and lows that other investors may feel. These highs and lows are known as “volatility” and they can make some people feel very nervous. Given the choice, most people would rather reach a long-term profit in a smooth upwards trajectory, rather than a spikey zigzag of profit and loss.
An investment plan which has a lot of highs and lows can also affect the way that you choose to invest, and not for the better. Studies have shown that 85% of investment performance is governed by investor behaviour. Impulse investing is a very real risk for performance, which is usually driven by greed or fear, and not by strategy. Keeping your investment performance as smooth and steady as possible could be a bonus for your wellbeing as well as your finances.
The opportunity cost of waiting to receive a lump sum could be stunting your money’s growth
Drip-feeding smaller amounts of money regularly into your investment could be a pragmatic and sustainable approach to money management. Whereas waiting around for a lump sum to hit your bank account before you start could be costing you valuable time. This is the time that you could be using to grow the money you already have.
Waiting to invest and consequently missing out on potential investments or compounding returns is referred to as your “opportunity cost”. It essentially means “what could your money be worth if you had done something different?”. It’s a serious question for investment analysts who will calculate the likelihood of hundreds of different scenarios when they weigh up investment choices. It is also a serious consideration for you. Would you rather spend your money now or invest it for later in life? What kind of retirement lifestyle could you afford later if you added regular payments to your investment portfolio now? These are important opportunity cost questions for you to consider, which will impact you later. Whether or not you choose to invest, you encounter opportunity costs with your money every day. For example, when you pay £2 for a latte, you are losing the opportunity that your £2 could grow if you had invested it in the coffee company instead.
Warren Buffet, the world-renowned investor famously kicked himself when he sold his first stock too soon, aged 11. Missing out on the lost profit got to him so much, that he decided to build his investment career around this opportunity cost. Today he factors in every opportunity when dealing with his money and is worth an estimated $87.3 billion. Adding regular deposits to your investment plan means that you make the most of the opportunities you have now.
For many people there is also the risk that the lump sum they are expecting will never arrive. For example, a recent BBC report showed that many millennials are falsely relying on inheritance to purchase their first home. They expect to receive around £130,000 before they hit 35. However, the reality is that they are far more likely to receive around £11,000 between the ages of 55 and 64. Imagine if you had decided to delay investing until you had received an inheritance. That could have been a hugely costly mistake to make, which would affect your standard of living throughout your retirement years.
It’s a similar story if you are planning to downsize your home to free up cash. With the best age to downsize being 64 years old, you could have missed out on some valuable opportunities over your investing lifetime.
Missing out on returns that you could be earning because you are waiting for a large lump sum could be costing you your retirement.
Is it possible to reap the benefits of both drip feeding and lump sum investing?
There is a way to maximise your potential return and take advantage of both worlds. This is to invest with both lump sums and drip feeding. You could get started with whatever amount you can afford, as soon as you can. Some months that may be as little as £3, other months that could be several thousands of pounds. Everyone’s journey is different, and you may have more or less financial muscle at different points in time. The thing that stays the same for everyone is that investing early on and keeping your investments for the long term is more likely to make you more wealthy. The earlier you begin, the more time your money has to grow and compound. Getting started early is fundamental for success, even if you can only afford a couple of pounds in the first month, it is better than delaying.
To illustrate this point, we can look to the story of another secret millionaire like Grace Groner. This is the story of the unassuming Anne Scheiber. She used a blend of lump sum investing and drip feeding to build up her fortune over time.
In the mid 1940s Anne decided to invest a lump sum of $5000 which she had managed to save up. She researched well and put her money into sensible investments, across a mix of bonds, cash, stocks and shares. The investments were not masterminded by an expert or overly complicated, they were simple and well thought-out. Anne always reinvested her profits back into her plan, so that her money grew, benefitting from the power of compounding over time. She also added to her investments regularly (drip feeding) with whatever she could afford. After 50 years of compounding and pound-cost averaging, her investments were worth a staggering $22 million.
This story goes to show how a mix of lump sum investing and drip feeding can create extraordinary returns for investors. It also demonstrates how almost anyone can do it. You do not need to be especially wealthy or in-the-know to maximise your potential finances. Here at Wealthify this is at the heart of our thinking. We believe that everyone has the potential to become an investor and potentially afford their dreams. Whether it is that once-in-a-lifetime trip, your child’s private education or a comfortable retirement, we want to help you get there.
Our leading investment team can manage your investments for you. Starting from as little as you like, you could benefit from the perks of being an investor, with none of the hassle. As well as drip feeding money, or lump sum investing, there is another even simpler way to grow your wealth. With a Stocks and Shares ISA, you benefit from tax relief on up to £20,000 (subject to change) invested every year. This is what makes ISAs so special. If you wanted to invest without using an ISA, you would be looking at paying income tax and capital gains tax. However this is not the case with a Stocks and Shares ISA, where you can keep more of your returns to truly maximise your earning potential.
To get started and make the most of your annual ISA allowance, visit our Stocks and Shares ISA page.
The tax treatment depends on your individual circumstances and may be subject to change in the future.
Please remember the value of your investments can go down as well as up, and you could get back less than invested.